Can we see the future?
If we are looking in the right places, we can see the future. For example, nearly two decades ago, someone saw how the Internet, with its open software and its open protocols would soon dramatically alter our future. His contribution was Mosaic, which we now know as the Firefox browser.
His name is Marc Andreessen and to him, the Internet was a reaction to the closed and proprietary networks and systems that existed. One industry after another has been completely reinvented as the result of mass collaboration using open systems. Business and technology book author Don Tapscott refers to when this happens as the rebooting of an industry.
This article is about how mass collaboration and open systems are being brought somewhere new entirely. If you’re looking at what I am looking at you too might conclude that this is something that deserves your attention. What I’m looking at is Bitcoin. When I look at Bitcoin I see the rebooting of our systems of money.
What is Bitcoin?
Bitcoin is a digital currency. It is an open digital currency.
It can be called open because it is built with open software, transacts through an open protocol and communicates peer-to-peer, over the Internet. Bitcoin is open, end-to-end.
That is a foreign concept to our systems of money. When describing the banking and financial services industries, rarely will the words open, universal, or free come to mind.
Bitcoin is defined by these words.
Bitcoin is a reaction to today’s closed and proprietary monetary networks and systems that exist. A reaction, a fix, a solution.
Bitcoin and the Functions of Money
Bitcoin is simply a combination of proven technologies that when assembled this certain way provides very well the differing functions of money. Though Bitcoin is not the first digital currency, it is unique in that it is the first currency that can be described using those words: open, universal and free.
One of the functions of money is to serve as a medium of exchange. That is the primary reason that digital currencies even exist. For Bitcoin, there are multiple exchanges to convert to and from other currencies, such as the dollar. However, Bitcoin is not yet a mature medium of exchange compared to government issued currencies, for example. As Bitcoin gains traction though it will become much better at performing this function.
Another function of money is to perform as a store of value. Bitcoins are a scarce commodity. The amount of Bitcoin currency that exists now is a relatively small number. Additional currency that is produced occurs on a schedule and at a known, predetermined rate. When the amount of currency reaches a specified limit, no additional currency will be added. This scarcity is by design so that bitcoins will hold their value. Bitcoin currency thus can function very well as a store of value.
Thirdly, money must be able to function as a unit of account. Again, digital currencies meet this requirement easily. This means that they are divisible and that each of my bitcoins is worth the exact same amount as each of yours.
Sending and Receiving Money
I describe these three functions to show why the output from a piece of software called Bitcoin can be considered to be money. Next, I’ll describe the mechanics of how Bitcoin is actually used as money.
Bitcoin uses the term wallet to refer to where your bitcoins are stored. If I’m running the Bitcoin software on my computer then I have a wallet stored locally on my hard drive which holds my bitcoins. I could instead use an online service and store my bitcoins with them.
If I’m going to pay to you some amount, you would first provide to me the Bitcoin address where you want payment sent. From my computer I then enter the amount, click send, and that number of bitcoins go directly from my wallet to that address.
If your wallet is on your computer, the Bitcoin software will instantaneously show my payment to you. It does take about an hour for that transaction to clear. I’ll describe what I mean with the term to clear a little later.
The money I sent to you was for a certain amount of bitcoins. That transaction clears at par value, meaning that If I send to you one hundred bitcoins, you receive in your wallet all one hundred bitcoins. If there is a transaction fee necessary for that payment, that’s something that I, as the sender, would pay.
The reason there could be a fee is because there is a cost to process and store these transactions. At the present time, however, there’s no fee that needs to be paid when sending money and I’ll explain why that is a little later as well.
Buying In and Cashing Out
Let’s say you now have these one hundred bitcoins in your wallet. How much are they worth?
Bitcoin is intended to be universal. If you are in the U.S., you’ll want to know what your bitcoins are worth in dollars. For that, there’s an online exchanger which provides a rate at which you can convert your bitcoins to dollars. Using the current rate, a bitcoin is worth about $1000 U.S. each.
Bitcoin is quite a young project. It was first released about several years ago. It’s only been in the past couple of years though that it’s been getting any attention to speak of. Because of the small size of the community yet, converting bitcoins to most other currencies can still be a challenge. As the community grows though, options for converting to and from other currencies is improving and a network effect seems to be taking hold.
Before I could send the money to you, I first needed to acquire bitcoins and to deposit them into my wallet. One way I can do that is to buy bitcoins from someone who is selling them, through an exchange, for example. To earn some bitcoins I can also sell goods or services where the buyer pays me with bitcoins from their wallet.
If I’m cashing out my bitcoins by converting them into dollars only to buy them back later because I need bitcoins for something else, then I’m losing some percent of my money because those conversions usually incur fees. Instead if I keep my bitcoins and use them to pay for purchases that I make, then I’ll save by not incurring those exchange fees.
Currently there are several places where you can buy using bitcoins and Bitcoin has started appearing as a payment option available with online shopping cart software and is just now starting to gain some traction for ecommerce.
For the most part then, think of transacting using bitcoins just as you would transact with a foreign issue of currency.
There is a difference though. Each of those currencies are issued and backed by a government. Who issues bitcoins and how are they backed?
How Bitcoin Currency is Issued
As of now, there are just over 15 million bitcoins in existence. The first one was issued in January, 2008, so not too long ago if we compare it to traditional payment systems. Additional Bitcoin currency is currently issued fifty bitcoins at a time and issuance occurs roughly once every ten minutes.
When Bitcoin is described using the term peer-to-peer, what that means is that the processing and storing of data occurs on computing nodes that are distributed across the Internet. Today there are several thousand nodes running Bitcoin located in several dozen countries. There is no master node. Anyone can download the open source Bitcoin software and configure it to perform as a node.
What all these nodes are doing are accepting transactions and crunching some numbers. All those nodes, except for one though, will be wasting its time. All but one. Each node is crunching away trying to become the one lucky node that happens to be the first to essentially guess the right number.
That one node that makes the right guess then seals the batch of transactions that it had accumulated and makes an announcement to other nodes in the network. As a reward for performing that necessary work, that node is given a reward. It is given fifty bitcoins. That’s how Bitcoin currency gets issued. When you run as a node and have your computer crunch numbers to earn the reward, that activity is called mining.
On average, a lucky guess occurs about once every ten minutes. As more nodes come online and more mining occurs it starts to take less and less time before one of those nodes makes the right guess. Periodically, the system will recalibrate, putting the frequency back to about once every ten minutes. All the bitcoins that have been and ever will be issued are rewards — fifty at a time, every ten minutes.
I want to use the more correct terms here. That number crunching that I’m referring to? What the computer is doing is called hashing. A block is the term used to refer to to that group of transactions that gets processed. The work performed by each of those lucky nodes is to solve the block. When a block gets solved, those additional bitcoins from the reward are generated.
Bitcoin’s Global Reach
Remember, anyone can be a node. A node can be located anywhere. This new currency then is being seeded to individuals around the world who mine. This method of seeding Bitcoins is introducing them globally. Globally, but not evenly. Here’s why.
To participate in mining bitcoin, you need to first know about it. Most of the documentation for Bitcoin is only available in English. Bitcoin has barely registered on the radar even for those who follow technical topics and who get their information generally from English language sources.
Even if you do learn about Bitcoin’s existence, mining it is an activity that is dependent on an always-on and unrestricted Internet. We know that these two characteristics are not universally available.
The amount of the hashing work that your node can perform is dependent on your computer hardware. The faster your computer, the more hashing it will perform, and the more rewards it will earn. However, for hashing work, even the fastest computers are no match compared to the off-the-shelf graphics cards that go into gaming systems. Those gamer cards contain GPUs which can calculate hashes several hundred times faster than most CPUs can.
Though the classic Bitcoin client software is available for Mac, Windows and Linux, those most efficient at mining Bitcoin today are those running Linux or Windows servers dedicated to mining with optimized software and contain the most expensive variants of graphics cards.
Thus the profile of the typical miner generating bitcoins would be:
- their primary language is English
- able to afford an expensive graphics card or two
- ability to buy from a supplier of the graphics cards whose supply is currently limited
- connected through reliable and unrestricted Internet access
- a skillset that includes administering servers, especially Linux-based ones, and
- ability to invest a fair amount of time in this technology
These are uber geeks.
If Bitcoin is to be universal, its distribution needs to become less skewed than this profile would otherwise produce. Of all bitcoins that will ever be issued, 75% have yet to be issued though. Additionally, those wishing to obtain a currency stake today can purchase bitcoins at market rates through the exchanges.
The rewards for the mining work can also include compensation in the form of transaction fees. At some point the size of the block generation reward will drop in half from fifty bitcoins to twenty-five. Years later, the reward will drop by half again, and continue doing so until such time that all twenty one million bitcoins have been issued.
A transaction fee at some point then will become the primary incentive to miners. That’s the mechanism to ensure that there’s an adequate number of nodes always available. Transaction fees are currently not necessary as miners are willing to compete just for the fifty bitcoin reward. Since the protocol and software are open, competition will likely keep these fees very low indefinitely.
Today the primary constraint for a miner is the capital required for purchasing the computing hardware. Tomorrow the constraints will likely be the availability of the hardware and the cost of the electricity to run it.
I’ve described why Bitcoin qualifies as money. I’ve described how bitcoins are created and some of the ways how they are used. Next I’d like to tell you why I believe Bitcoin has so much potential.
Sometimes you will see two gas stations right next to each other, where the sign for one shows a price ten cents a gallon less than the price at the other. Of course, the reason why this occurs is because one accepts cash or debit transactions only and the other, the more expensive one, accepts credit cards for payment as well. That price difference reflects the payment network fee and is significant enough that some will take their business down the street to avoid paying for a service that they don’t plan to use.
Consumers may prefer to use bitcoins to pay for their online purchases if they can receive a lower price as the result. Merchants may prefer to be paid with bitcoins for several reasons as well:
- Firstly, Bitcoin has marginalized the costs for operating a payment network. Today there are no fees to transact on the network. None. In a price-competitive environment, a merchant who wishes to pass on those savings to the consumer can use this as a competitive advantage.
- Another reason is Bitcoin’s immediate clearing and settlement. A Bitcoin transaction clears after it has been confirmed by a number of those network nodes who have generated blocks. As a rule of thumb, consider this as something that takes just about an hour. Those funds are then available to the recipient for spending with no further delay.
- Thirdly, and some merchants might really like this, payments through Bitcoin are not reversible. There are no chargebacks.
Describing Bitcoin as just a cheaper or better alternative to current payment methods doesn’t explain what’s really happening though.
There’s never before been a type of money anything like Bitcoin.
As a currency compared to a government-issued fiat currency, Bitcoin has no central bank and there’s no button to press that will inflate the supply. The amount of currency stock that will exist one year out, two years out and ten years out, is known today.
Even compared to scarce commodities, like gold, for instance, something like Bitcoin has never before existed. When the price for gold is high like what we see today physical mining activity accelerates and the supply of gold is increased. Bitcoin’s supply is inelastic. Regardless of price or demand, it increases fifty bitcoins every ten minutes.
Having these numbers known in advance and known publicly means that there are no inefficiencies due to information disparity and speculation regarding the currency supply.
I’ve described why consumers might have reason to like Bitcoin, why merchants might have reason to like Bitcoin, and why Investors might have reason to like it as well.
Privacy and Freedom
Additionally, consider this. To send or receive bitcoins you don’t need to register your name or any other identity anywhere. You can send and receive payments, using the Bitcoin client software running from your computer, anywhere that you have access to the Internet. As a result, anonymity, or at least, pseudonymity, is very likely attainable. It’s the same level of anonymity you might get when paying with cash.
That being said, there is this. Every transaction starting with the very first one, is visible — publicly. Meaning that every transaction has a pedigree. Every bit of that money for that transaction came from somewhere.
When I buy a something online and have it shipped to me, the seller knows the Bitcoin address that I gave them when I made my purchase. That address then leads back to the Bitcoin address where I got the funds from. And back further to where those funds came from. And on and on. By themselves, Bitcoin transactions don’t reveal your identity — however, tied with external data, such as my shipping address for my coffee purchase, anonymity for me and for those with whom I trade may not necessarily be a guarantee at some point. At least that’s a topic that’s being discussed.
At the same time though, it is possible that this type of technology will frustrate governments, banks and corporations to the Nth degree. Whether anonymity is a flaw or a feature may depend on your perspective.
Bitcoin does that. It varies based on your perspective. Ask five users what Bitcoin means to them and you’ll get five different answers.
Perhaps this story about my neighbor will help me to explain myself. When I used to take the train into work each day I met another commuter who worked near where I worked, and later I learned that he lived just blocks from where I lived. My commute could have been quicker if I were able drive instead and take advantage of the carpool lane. I offered to drive my neighbor to and from work at no charge. He declined. To him, knowing that not one ounce of gasoline was being burned for his commute was something that was that important to him.
Bitcoin has the same effect on certain people. For reasons that are as emotional and personal as they are sensible, Bitcoin grabs hold of many people.
Here you have this distributed computing software project, with no corporate backing, no budget, no formal organizational structure, a founder whose identity is uncertain and who provides guidance only on occasion — yet the project is growing hand over fist.
To me, Bitcoin is the cure for many of the ails that I’ve seen with our current systems of money.
If I want to start accepting Bitcoin as payment, there’s no merchant agreement I need fill out, there’s no credit check I need to submit to, there’s no probationary period or restrictions that apply and there’s no three day hold before I have access to the money that I’ve earned.
When I consider what Bitcoin is, I also consider what it is not. Bitcoin is not the system designed by bankers to guarantee that they would have profits for generations to come. Bitcoin is not the system designed by governments to protect and serve themselves. Bitcoin is not some system designed to generate marketing data and a revenue stream for some ploy that large corporations have conjured up. Bitcoin is the implementation in software of an idea that brings us privacy and freedom.
Bitcoin’s biggest fans are those who dig the technology and those who value liberty. These kinds of people are found throughout the world.
Look at this thing they are creating and you too might believe that what you are seeing is the future.